Nonperforming Asset in Bank

CHAPTER1: INTRODUCTION
A strong banking sector is important for flourishing economy. One of the most
important and major roles played by banking sector is that of lending business. It is
generally encouraged because it has the effect of funds being transferred from the
system to productive purposes, which also results into economic growth. As there
are pros and cons of everything, the same is with lending business that carries
credit risk, which arises from the failure of borrower to fulfill its contractual
obligations either during the course of a transaction or on a future obligation. The
failure of the banking sector may have an adverse impact on other sectors.

Non- performing assets are one of the major concerns for banks in India. NPAs
reflect the performance of banks. A high level of NPAs suggests high probability
of a large number of credit defaults that affect the profitability and net-worth of
banks and also erodes the value of the asset. The NPA growth involves the
necessity of provisions, which reduces the overall profits and share holders value.
The issue of Non Performing Assets has been discussed at length for financial
system all over the world. The problem of NPAs is not only affecting the banks but
also the whole economy. In fact high level of NPAs in Indian banks is nothing but
a reflection of the state of health of the industry and trade. This project deals with
understanding the concept of NPAs, its magnitude and major causes for an account
becoming non-performing, projection of NPAs over next years in banks and
concluding remarks.

The magnitude of NPAs have a direct impact on Banks profitability legally they
are not allowed to book income on such accounts and at the same time banks are
forced to make provisions on such assets as per RBI guidelines The RBI has
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advised all State Co-operative Banks as well as the Central Co-operative Banks in
the country to adopt prudential norms from the year ending 31-03-1997. These
have been amended a number of times since 1997. As per their guidelines the
meaning of NPAs, the norms regarding assets classification and provisioning. Its
now very known that the banks and financial institutions in India face the problem
of amplification of non-performing assets (NPAs) and the issue is becoming more
and more unmanageable. In order to bring the situation under control, various steps
have been taken. Among all other steps most important one was the introduction of
Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 by Parliament, which was an important step towards elimination
or reduction of NPAs.

An asset is classified as non-performing asset (NPAs) if dues in the form of

principal and interest are not paid by the borrower for a period of 180 days,
however with effect from March 2004, default status would be given to a borrower
if dues are not paid for 90 days. If any advance or credit facility granted by bank to
a borrower becomes non-performing, then the bank will have to treat all the
advances/credit facilities granted to that borrower as non-performing without
having any regard to the fact that there may still exist certain advances / credit
facilities having performing status.

The NPA level of our banks is way high than international standards. One cannot
ignore the fact that a part of the reduction in NPAs is due to the writing off bad
loans by banks. Indian banks should take care to ensure that they give loans to
credit worthy customers. In this context the dictum prevention is always better
than cure acts as the golden rule to reduce NPAs.
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Nonperforming Asset in Bank

NON PERFORMING ASSETS (NPA) - CONCEPT

Non Performing Asset means an asset or account of borrower, which has been
classified by a bank or financial institution as sub-standard, doubtful or loss asset,
in accordance with the directions or guidelines relating to asset classification
issued by The Reserve Bank of India. An asset, including a leased asset, becomes
nonperforming when it ceases to generate income for the bank. A NPA is a loan or
an advance where Interest and/ or installment of principal remain overdue for a
period of more than 90 days in respect of a term loan. Earlier assets were declared
as NPA after completion of the period for the payment of total amount of loan and
30 days grace. In present scenario assets are declared as NPA if none of the
installment is paid till 180 days i.e. six months in respect of term loan. With effect
from march, 30, 2004, a non performing asset (NPA) shall be a loan or an advance
where: Interest and/or installments of principal remain overdue for a period of
more than 90 days in respect of a term loan, The account remains out of order
for a period of more than 90 days, in respect of an overdraft/cash credit (od/cd).
The bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted, interest and or installments of principal remains overdue
for two harvest seasons but for a period not exceeding two half years in the case of
advance granted for agricultural purpose, and any amount to be received remains
overdue for a period of more than 90 days in respect of other accounts.

RBI introduced, in 1992, the prudential norms for income recognition, asset
classification & provisioning IRAC norms in short in respect of the loan
portfolio of the Co operative Banks. The objective was to bring out the true picture
of a banks loan portfolio. The fallout of this momentous regulatory measure for
the management of the CBs was to divert its focus to profitability, which till then
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used to be a low priority area for it. Asset quality assumed greater importance for
the CBs when Maintenance of high quality credit portfolio continues to be a major
challenge for the CBs, especially with RBI gradually moving towards convergence
with more stringent global norms for impaired assets. The quality of a banks loan
portfolio can impact its profitability, capital and liquidity. Asset quality problems
are at the root of other financial problems for banks, leading to reduced net interest
income and higher provisioning costs. If loan losses exceed the Bad and Doubtful
Debt Reserve, capital strength is reduced. Reduced income means less cash, which
can potentially strain liquidity. Market knowledge that the bank is having asset
quality problems and associated financial conditions may cause outflow of
deposits. Thus, the performance of a bank is inextricably linked with its asset
quality. Managing the loan portfolio to minimize bad loans is, therefore,
fundamentally important for a financial institution in todays extremely
competitive and market driven business environment. This is all the more
important for the CBs, which are at a disadvantage of the commercial banks in
terms of professionalized management, skill levels, technology adoption and
effective risk management systems and procedures. Management of NPAs begins
with the consciousness of a good portfolio, which warrants a better understanding
of risks in lending. The Board has to decide a strategy keeping in view the
regulatory norms, the business environment, its market share, the risk profile, the
available resources etc. The strategy should be reflected in Board approved
policies and procedures to monitor implementation. The essential components of
sound NPA management are

i) Quick identification of NPAs,

ii) Their containment at a minimum level,

Nonperforming Asset in Bank

iii) Ensuring minimum impact of NPAs on the financials.

Types Of NPA:
The RBI has issued the guidelines to banks for classification of assets in to
following categories.

Standard assets: Standard Asset is one which does not disclose any problems and
which does not carry more than normal risk attached to the business/banks. These
are loans which do not have any problem are less risk. Such an asset is not a nonperforming asset. In other words, it carries not more than normal risk attached to
the business.

Sub Standard Assets: It is classified as non-performing for a period not exceeding

12 months. The account holder comes in this category when they dont pay three
installments continuously after 90 days and up to 1 year. For this category bank has
made 10% provision of funds from their profit to meet the losses generated from
NPA. With effect from March 31, 2005 an asset would be classified as substandard if it remained NPA for a period less than or equal to 12 months. In such
cases, the current net worth of the borrowers/ guarantors or the current market
value of the security charged is not enough to ensure recovery of the dues to the
banks in full. In other words, such assets will have well defined credit weaknesses
that jeopardize the liquidation of the debt and are characterized by the distinct
possibility that the banks will sustain some loss, if deficiencies are not corrected.

(ii) An asset where the terms of the loan agreement regarding interest and principal
have been re-negotiated or rescheduled after commencement of production, should
be classified as sub-standard and should remain in such category for at least 12
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months of satisfactory performance under the re-negotiated or rescheduled terms.

In other words, the classification of an asset should not be upgraded merely as a
result of rescheduling, unless there is satisfactory compliance of this condition.

Doubtful NPA: An asset that has remained an NPA for a period exceeding 12
months is a doubtful asset. These are NPA exceeding 12 months.
Under doubtful NPA there are three sub categories:
D1 i.e. up to 1 year: 20% provision is made by banks.
D2 i.e. up to 2 year: 30% provision is made by bank.
D3 i.e. up to 3 year: 100% provision made by bank.

With effect from March 31, 2005, an asset is required to be classified as doubtful,
if it has remained NPA for more than 12 months. The 12-month period of
classification of a substandard asset in doubtful category is effective from April 1,
2009. A loan classified as doubtful has all the weaknesses inherent as that
classified as sub-standard, with the added characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently known facts, conditions
and values, highly questionable and improbable.

Loss Assets: A loss asset is one where loss has been identified by the bank or
internal or external auditors or by the Co-operation Department or by the Reserve
Bank of India inspection but the amount has not been written off, wholly or partly.
In other words, such an asset is considered un-collectible and of such little value
that its continuance as a bankable asset is not warranted although there may be
some salvage or recovery value. Here loss is identified by the banks concerned, by
internal auditors, by external auditors, or by the Reserve Bank India upon

Nonperforming Asset in Bank

inspection. These NPA which are identified unreliable by internal inspector of

bank or auditors or by RBI. Under this 100% provision is made.
Effects of NPA on Bank:
1. Restriction on flow of cash done by bank due to the provisions of fund made
against NPA.
2. Drain of profit.
3. Bad effect on Goodwill.
4. Bad effect on equity value.

DIFFICULTIES WITH THE NON-PERFORMING ASSETS:

1. Owners do not receive a market return on their capital. In the worst case, if the
bank fails, owners lose their assets. In modern times, this may affect a broad pool
of shareholders.

2. Depositors do not receive a market return on savings. In the worst case if the
bank fails, depositors lose their assets or uninsured balance. Banks also redistribute
losses to other borrowers by charging higher interest rates. Lower deposit rates and
higher lending rates repress savings and financial markets, which hampers
economic growth.

3. Non- performing loans epitomize bad investment. They misallocate credit from
good projects, which do not receive funding, to failed projects. Bad investment
ends up in misallocation of capital and, by extension, labour and natural resources.
The economy performs below its production potential.

Nonperforming Asset in Bank

4. Non- performing loans may spill over the banking system and contract the
money stock, which may lead to economic contraction. This spillover effect can
channelize through illiquidity or bank insolvency;
(a) When many borrowers fail to pay interest, banks may experience liquidity
shortages. These shortages can jam payments across the country,
(b) Illiquidity constraints bank in paying depositors e.g. cashing their paychecks.
Banking panic follows. A run on banks by depositors as part of the national money
stock become inoperative. The money stock contracts and economic contraction
follows undercapitalized banks exceeds the banks capital base.

Lending by banks has been highly politicized. It is common knowledge that loans
are given to various industrial houses not on commercial considerations and
viability of project but on political considerations; some politician would ask the
bank to extend the loan to a particular corporate and the bank would oblige. In
normal circumstances banks, before extending any loan, would make a thorough
study of the actual need of the party concerned, the prospects of the business in
which it is engaged, its track record, the quality of management and so on. Since
this is not looked into, many of the loans become NPAs. The loans for the weaker
sections of the society and the waiving of the loans to farmers are another
dimension of the politicization of bank lending.

INCOME RECOGNITION
Income recognition Policy
The policy of income recognition has to be objective and based on the record
of recovery. Internationally income from non-performing assets (NPA) is
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not recognised on accrual basis but is booked as income only when it is

actually received. Therefore, the banks should not charge and take to income
account interest on any NPA.
However, interest on advances against term deposits, NSCs, IVPs, KVPs
and Life policies may be taken to income account on the due date, provided
adequate margin is available in the accounts.
Fees and commissions earned by the banks as a result of re-negotiations or
rescheduling of outstanding debts should be recognised on an accrual basis
over the period of time covered by the re-negotiated or rescheduled
extension of credit.
If Government guaranteed advances become NPA, the interest on such
advances should not be taken to income account unless the interest has been
realised.

Reversal of income:
If any advance, including bills purchased and discounted, becomes NPA as
at the close of any year, interest accrued and credited to income account in
the corresponding previous year, should be reversed or provided for if the
same is not realised. This will apply to Government guaranteed accounts
also.

Nonperforming Asset in Bank

In respect of NPAs, fees, commission and similar income that have accrued
should cease to accrue in the current period and should be reversed or
provided for with respect to past periods, if uncollected.

Leased Assets
The net lease rentals (finance charge) on the leased asset accrued and
credited to income account before the asset became non-performing, and
remaining unrealised, should be reversed or provided for in the current
accounting period.
The term 'net lease rentals' would mean the amount of finance charge taken
to the credit of Profit & Loss Account and would be worked out as gross
lease rentals adjusted by amount of statutory depreciation and lease
equalisation account.
As per the 'Guidance Note on Accounting for Leases' issued by the
Council of the Institute of Chartered Accountants of India (ICAI), a separate
Lease Equalisation Account should be opened by the banks with a
corresponding debit or credit to Lease Adjustment Account, as the case may
be. Further, Lease Equalisation Account should be transferred every year to
the Profit & Loss Account and disclosed separately as a deduction
from/addition to gross value of lease rentals shown under the head 'Gross
Income'.

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Nonperforming Asset in Bank

Appropriation of recovery in NPAs

Interest realised on NPAs may be taken to income account provided the
credits in the accounts towards interest are not out of fresh/ additional credit
facilities sanctioned to the borrower concerned.
In the absence of a clear agreement between the bank and the borrower for
the purpose of appropriation of recoveries in NPAs (i.e. towards principal or
interest due), banks should adopt an accounting principle and exercise the
right of appropriation of recoveries in a uniform and consistent manner.

Interest Application:
There is no objection to the banks using their own discretion in debiting interest to
an NPA account taking the same to Interest Suspense Account or maintaining only
a record of such interest in proforma accounts.

Reporting of NPAs
Banks are required to furnish a Report on NPAs as on 31 st March each year
after completion of audit. The NPAs would relate to the banks global
portfolio, including the advances at the foreign branches.

FACTORS FOR RISE IN NPAs

The banking sector has been facing the serious problems of the rising NPAs. But
the problem of NPAs is more in public sector banks when compared to private
sector banks and foreign banks. The NPAs in PSB are growing due to external as
well as internal factors.
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Nonperforming Asset in Bank

EXTERNAL FACTORS : Ineffective recovery tribunal

The Govt. has set of numbers of recovery tribunals, which works for
recovery of loans and advances. Due to their negligence and ineffectiveness
in their work the bank suffers the consequence of non-recover, their by
reducing their profitability and liquidity.
Willful Defaults
There are borrowers who are able to pay back loans but are intentionally
withdrawing it. These groups of people should be identified and proper
measures should be taken in order to get back the money extended to them
as advances and loans.

Natural calamities

This is the measure factor, which is creating alarming rise in NPAs of the
PSBs. every now and then India is hit by major natural calamities thus
making the borrowers unable to pay back there loans. Thus the bank has to
make large amount of provisions in order to compensate those loans, hence
end up the fiscal with a reduced profit.

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Nonperforming Asset in Bank

Mainly ours farmers depends on rain fall for cropping. Due to irregularities
of rain fall the farmers are not to achieve the production level thus they are
not repaying the loans.
Industrial sickness

Improper project handling , ineffective management , lack of adequate

resources , lack of advance technology , day to day changing govt. Policies
give birth to industrial sickness. Hence the banks that finance those
industries ultimately end up with a low recovery of their loans reducing their
profit and liquidity.
Lack of demand

Entrepreneurs in India could not foresee their product demand and starts
production which ultimately piles up their product thus making them unable
to pay back the money they borrow to operate these activities. The banks
recover the amount by selling of their assets, which covers a minimum label.
Thus the banks record the non recovered part as NPAs and has to make
provision for it.
Change on Govt. policies

With every new govt. banking sector gets new policies for its operation.
Thus it has to cope with the changing principles and policies for the
regulation of the rising of NPAs.

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Nonperforming Asset in Bank

The fallout of handloom sector is continuing as most of the weavers Cooperative societies have become defunct largely due to withdrawal of state
patronage. The rehabilitation plan worked out by the Central government to
revive the handloom sector has not yet been implemented. So the over dues
due to the handloom sectors are becoming NPAs.

INTERNAL FACTORS : Defective Lending process

There are three cardinal principles of bank lending that have been followed
by the commercial banks since long.

i.

i.

Principles of safety

ii.

Principle of liquidity

iii.

Principles of profitability

Principles of safety :-

By safety it means that the borrower is in a position to repay the loan

both principal and interest. The repayment of loan depends upon the
borrowers:

a. Capacity to pay
b. Willingness to pay

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Nonperforming Asset in Bank

Capacity to pay depends upon:

1. Tangible assets
2. Success in business
Willingness to pay depends on:
1. Character
2. Honest
3. Reputation of borrower
The banker should, therefore take utmost care in ensuring that the enterprise or
business for which a loan is sought is a sound one and the borrower is capable of
carrying it out successfully .he should be a person of integrity and good character.

Inappropriate technology

Due to inappropriate technology and management information system,

market driven decisions on real time basis cannot be taken. Proper MIS and
financial accounting system is not implemented in the banks, which leads to
poor credit collection, thus NPA. All the branches of the bank should be
computerized.
Improper SWOT analysis

The improper strength, weakness, opportunity and threat analysis is another

reason for rise in NPAs. While providing unsecured advances the banks
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depend more on the honesty, integrity, and financial soundness and credit
worthiness of the borrower.
Banks should consider the borrowers own capital investment.
it should collect credit information of the borrowers from_
a. From bankers.
b. Enquiry from market/segment of trade, industry, business.
c. From external credit rating agencies.

Analyze the balance sheet.

True picture of business will be revealed on analysis of profit/loss a/c
and balance sheet.

Purpose of the loan

When bankers give loan, he should analyze the purpose of the loan.
To ensure safety and liquidity, banks should grant loan for productive
purpose only. Bank should analyze the profitability, viability, long
term acceptability of the project while financing.
Poor credit appraisal system

Poor credit appraisal is another factor for the rise in NPAs. Due to poor
credit appraisal the bank gives advances to those who are not able to repay it
back. They should use good credit appraisal to decrease the NPAs.

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Managerial deficiencies

The banker should always select the borrower very carefully and should take
tangible assets as security to safe guard its interests. When accepting
securities banks should consider the_

1. Marketability
2. Acceptability
3. Safety
4. Transferability.

The banker should follow the principle of diversification of risk based on the
famous maxim do not keep all the eggs in one basket; it means that the
banker should not grant advances to a few big farms only or to concentrate
them in few industries or in a few cities. If a new big customer meets
misfortune or certain traders or industries affected adversely, the overall
position of the bank will not be affected.

Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand loom
industries. The biggest defaulters of OSCB are

the OTM

(117.77lakhs), and the handloom sector Orissa hand loom WCS ltd
(2439.60lakhs).

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Nonperforming Asset in Bank

Absence of regular industrial visit

The irregularities in spot visit also increases the NPAs. Absence of regularly
visit of bank officials to the customer point decreases the collection of
interest and principals on the loan. The NPAs due to willful defaulters can
be collected by regular visits.

Re loaning process

Non remittance of recoveries to higher financing agencies and re loaning of

the same have already affected the smooth operation of the credit cycle.

Due to re loaning to the defaulters and CCBs and PACs, the NPAs of OSCB
is increasing day by day.

PROBLEMS DUE TO NPA

1. Owners do not receive a market return on their capital .in the worst case, if
the banks fails, owners lose their assets. In modern times this may affect a
broad pool of shareholders.
2. Depositors do not receive a market return on saving. In the worst case if the
bank fails, depositors lose their assets or uninsured balance.

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3. Banks redistribute losses to other borrowers by charging higher interest

rates, lower deposit rates and higher lending rates repress saving and
financial market, which hamper economic growth.
4. Nonperforming loans epitomize bad investment. They misallocate credit
from good projects, which do not receive funding, to failed projects. Bad
investment ends up in misallocation of capital, and by extension, labour and
natural resources.
Nonperforming asset may spill over the banking system and contract the money
stock, which may lead to economic contraction. This spillover effect can
channelize through liquidity or bank insolvency:
a) When many borrowers fail to pay interest, banks may experience

liquidity

shortage. This can jam payment across the country,

b) Illiquidity constraints bank in paying depositors
.c) Undercapitalized banks exceeds the banks capital base.

The three letters Strike terror in banking sector and business circle today. NPA is
short form of Non Performing Asset. The dreaded NPA rule says simply this:
when interest or other due to a bank remains unpaid for more than 90 days, the
entire bank loan automatically turns a non performing asset. The recovery of loan
has always been problem for banks and financial institution. To come out of these
first we need to think is it possible to avoid NPA, no cannot be then left is to look
after the factor responsible for it and managing those factors.
Interest and/or instalment of principal remains overdue for two harvest
seasons but for a period not exceeding two half years in the case of an
advance granted for agricultural purposes, and
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Any amount to be received remains overdue for a period of more than 90

days in respect of other accounts.

As a facilitating measure for smooth transition to 90 days norm, banks have been
advised to move over to charging of interest at monthly rests, by April 1, 2002.
However, the date of classification of an advance as NPA should not be changed
on account of charging of interest at monthly rests. Banks should, therefore,
continue to classify an account as NPA only if the interest charged during any
quarter is not serviced fully within 180 days from the end of the quarter with effect
from April 1, 2002 and 90 days from the end of the quarter with effect from March
31, 2004.

'Out of Order' status:

An account should be treated as 'out of order' if the outstanding
balance remains continuously in excess of the sanctioned limit/drawing power. In
cases where the outstanding balance in the principal operating account is less than
the sanctioned limit/drawing power, but there are no credits continuously for six
months as on the date of Balance Sheet or credits are not enough to cover the
interest debited during the same period, these accounts should be treated as 'out of
order'.
Overdue:
Any amount due to the bank under any credit facility is overdue if it
is not paid on the due date fixed by the bank.

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CHAPTER2: REVIEW OF LITERATURE

A number of studies related to performance and over dues of banking sector have
been conducted by many researchers and institutions in India. An analytical
attempt is being made to review some related works done to organize them in a
presentable form.
I. Studies Prior to Financial Sector Reforms (1991):
The Maclegan Committee (1914), which is the historical document in the annals
of cooperative movement, has examined the performance of credit cooperatives. It
stated that when the funds are kept rotating, any loaning function of the bank can
gear up successfully and serve very useful purpose. Unless the loans are repaid
punctually, cooperation is both financially and educationally an illusion.

Kalyani (1970) emphasized on a longer period for the repayment of long term
loans in India. He added that the total burden of interest would be relatively higher
in the long period than in the shorter period, but then this burden would be spread
over quite a long period, making it easier for the borrower to repay his loan in easy
installments, thereby resulting in lesser overdue.

The All India Rural Credit Review Committee (1972) strongly stated that there is
an utter lack of administrative supervision, staff of right type and the requisite
scale of and, therefore, a full check on the utilization of loans is rather difficult.
Further it pointed out that the cooperative system had remained stagnant both in
respect of coverage of credit as well as borrowing members as proportion to the
total number of members. Cooperative credit was short of standards of timeliness,
adequacy and dependability. Generally the over dues were heavy and were rising
from year to year.
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Datey, the Chairman of the Report of the study team on over dues in cooperative
credit institutions (1974) studied the problem of over dues in cooperative banks
and remarked. About three fourths of over dues arose due to willful default besides
internal reasons. And he suggested that stern action on recalcitrant borrowers
should be taken up.

Economic Survey (2005-2006), Monetary and Banking Developments: According

to this survey, the target for institutional credit for agriculture by all the agencies
was fixed at Rs.105,000 cores for the year 2004-05,ensuring 30% growth over
previous years achievement. The overall achievement by all agencies during 200405 was 1, 15,243 cores, equivalent to 32% growth over the previous years
achievement. It further highlighted that while the Commercial Banks and Regional
Rural Banks over performed vis--vis their target of Rs 57000 crores and 8500
crores, there was a shortfall of over Rs.8000 crores by Cooperative Banks vis--vis
their target of 39,000 crores, attributing the same to low resource base and
inefficient recovery system, thereby leading to excessive Overdue. The position of
NPAs has significantly improved in Scheduled Commercial Banks due to wider
options available to these for recovery of their dues on one hand and sale of their
NPAs to Asset Reconstruction Co (India) limited (ARCIL) on the other hand. This
resulted in NPAs declining by 6487 crores between March 2004 and end March
2005.
Bagchi, (2006). made an attempt to analyze the performance of Cooperative Credit
Institutions especially Primary Agriculture Credit Societies, and observed that
PACS could not match up to the increasing requirements of growth dimensions in
the Agri /Rural developments in the Post Independence Period, although till the
late 50s, they were the only available source of institutional rural finance.
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According to the RBI Report on Trend and Progress of Banking in India 2004-05,
released on 24-11-05, the Cooperative Credit Institutions had extended an amount
of Rs.39, 638 crores to Agri-Allied sectors i.e., about half of credit advanced by
Commercial Banks (72,886 crores) and double the amount advanced by RRBs
(11,718 crores). The dismal performance of Cooperative Banks was due to
unnecessary State Government intervention and above all the inefficient loan
recovery system leading to NPAs.

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Nonperforming Asset in Bank

CHAPTER3: RESEARCH METHODOLOGY

For accomplishing the objectives of the study, both secondary and primary data
will be analyzed.

1. Secondary Data:
The Secondary Data for three years from 2006 to 2008 will be used for the purpose
of this study. The data will be collected from:
(1) The Annual Accounts, Audit Reports, and Inspection Reports of the selected
DCCBs.
(2) Publications of Reserve Bank of India.
(3) Publications of NABARD.
(4) Economic Surveys
(5) Existing literature and other scholarly works.

2. Observation: Some information will be gathered through personal observation

and interaction with the officials of NABARD and State Cooperative Banks.

Tools of Analysis:
Consistent with the objectives of the study, different accounting techniques such as
Ratio analysis, etc., will be utilized. In addition to these, simple statistical
techniques like averages, graphs, percentages may be used aiming at the
achievement of study objectives and findings of the existing studies.

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Nonperforming Asset in Bank

Objectives of the study

To understand the meaning & nature of NPAs.
To project the NPAs in bank over next three years.
To analyze the NPA and its relation with operating profit of the bank.
To study the general reasons for assets become NPAs.
To point out the amount of NPAs in different central banks.
What are the criteria to recover the advances from the bank.
What are the methods adopted by the bank to look after NPA management.

Scope of this study:

To know how NPA level will affect the profit of the banks.

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CHAPTER4: FINDINGS & RECOMMENDATION CAUSES OF

NPAS IN BANKS
Non-performing Assets (NPAs) are the smoking gun threatening the very stability
of Indian banks. NPAs wreck a bank's profitability both through a loss of interest
income and write-off of the principal loan amount itself. In a bid to stem the
lurking rot, RBI issued in 1993 guidelines based on recommendations of the
Narasimham Committee that mandated identification and reduction of NPAs. Their
implementation immediately pushed many banks into the red. So serious is the
problem that an RBI report suggested that reducing NPAs be treated as a 'national
priority'

Dealing with NPAs involves two sets of policies

1. Relating to existing NPAs
2. To reduce fresh NPA generation.
As far as old NPAs are concerned, a bank can remove it on its own or sell the
assets to AMCs to clean up its balance sheet. For preventing fresh NPAs, the bank
itself should adopt proper policies.
A strong banking sector is important for a flourishing economy. The failure of the
banking sector may have an adverse impact on other sectors. The Indian banking
system, which was operating in a closed economy, now faces the challenges of an
open economy. On one hand a protected environment ensured that banks never
needed to develop sophisticated treasury operations and Asset Liability
Management skills. On the other hand a combination of directed lending and social
banking relegated profitability and competitiveness to the background. The net
result was unsustainable NPAs and consequently a higher effective cost of banking
services. One of the main causes of NPAs into banking sector is the directed loans
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system under which central co operative banks are required a prescribed

percentage of their credit (40%) to priority sectors. As of today nearly 7 percent of
Gross NPAs are locked up in 'hard-core' doubtful and loss assets, accumulated over
the years.

The problem India Faces is not lack of strict prudential norms but
i. The legal impediments and time consuming nature of asset disposal proposal.
ii. Postponement of problem in order to show higher earnings. iii. Manipulation of
debtors using political influence.
Causes for an Account becoming NPA
There are several reasons for an account becoming NPA.
* Internal factors
* External factors

Internal factors:
1. Funds borrowed for a particular purpose but not use for the said purpose.
2. Project not completed in time.
3. Poor recovery of receivables.
4. Excess capacities created on non-economic costs.
5. In-ability of the corporate to raise capital through the issue of equity or other
debt instrument from capital markets.
6. Business failures.
7. Diversion of funds for expansion\modernization\setting up new projects\
helping or promoting sister concerns.
8. Willful defaults, siphoning of funds, fraud, disputes, management disputes,
miss-appropriation etc.
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Nonperforming Asset in Bank

9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and
follow-ups, delay in settlement of payments\ subsidiaries by government bodies etc
External factors:
1. Sluggish legal system
Long legal tangles
Changes that had taken place in labour laws
Lack of sincere effort.

2. Scarcity of raw material, power and other resources.

3. Industrial recession.
4. Shortage of raw material, raw material\input price escalation, power shortage,
industrial recession, excess capacity, natural hazards like floods, accidents.
5. Failures, nonpayment\ over dues in other countries, recession in other countries,
externalization problems, adverse exchange rates etc.
6. Government policies like excise duty changes, Import duty changes etc.
Some Other Reasons:
Failure to bring in Required capital
Too ambitious project
Miss management
Unwanted Expenses
Over trading
Imbalances of inventories
Lack of proper planning
Dependence on single customers
Lack of expertise
Improper working Capital Mgmt.
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Nonperforming Asset in Bank

Treatment of Accounts as NPAs

Record of Recovery
The treatment of an asset as NPA should be based on the record of recovery. Banks
should not treat an advance as NPA merely due to existence of some deficiencies
which are of temporary in nature such as non-availability of adequate drawing
power, balances outstanding exceeding the limit. A credit facility should be treated
as NPA.
Treatment of NPAs Borrower-wise and not Facility-wise
I. In respect of a borrower having more than one facility with a bank, all the
facilities granted by the bank will have to be treated as NPA and not the particular
facility or part thereof which has become irregular.
II. However, in respect of consortium advances or financing under multiple
banking arrangements, each bank may classify the borrower accounts according to
its own record of recovery and other aspects having a bearing on the recoverability
of the advances.

Recognition of Income on Investment Treated as NPAs

The investments are also subject to the prudential norms on income recognition.
Banks should not book income on accrual basis in respect of any security
irrespective of the category in which it is included, where the interest/principal is
in arrears for more than 90 days.

NPA Reporting to Reserve Bank

Banks should report the figures of NPAs to the Regional Office of the Reserve
Bank at the end of each year within two months from the close of the year.

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Nonperforming Asset in Bank

CHAPTER5: SUGGESTIONS TO REDUCE N.P.A

At the pre-disbursement stage, appraisal techniques of bank need to be sharpened.
All technical, economic, commercial, organizational and financial aspects of the
project need to be assessed realistically. Bankers should satisfy themselves that the
project is technically feasible with reference to technical knowhow, scale of
production etc. The project should be commercially feasible in that all background
linkages by way of availability of raw materials at competitive rates and that all
forward linkages by way of assured market are available. It should be ensured
assumptions on which the project report is based are realistic. Some projects are
born sick because of unrealistic planning, inadequate appraisal and faulty
implementation. As the initiative to sanction or reject the project proposal lies with
the banker, he can exercise his judgment judiciously. The banker should at the presanction stage not only appraise the project but also the promoter his character
and his capacity. It is said that it is more prudent to sanction a B class project
with an A class entrepreneur than vice-versa. He has to ensure that the borrower
complies with all the terms of sanction before disbursement.

A major cause for NPA is fixation of unrealistic repayment schedule. Repayment

schedule may be fixed taking into account gestation or moratorium period,
harvesting season, income generation, surplus available etc. If the repayment
schedule is defective both with reference to quantum of installment and period of
recovery, assets have a tendency to become NPA. At the post-disbursement stage,
bankers should ensure that the advance does not become and NPA by proper
follow-up and supervision to ensure both assets creation and asset utilization.
Bankers can do either off-site surveillance or on site inspection to detect whether
the unit / project is likely to become NPA. Instead of waiting for the mandatory
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Nonperforming Asset in Bank

period before classifying an asset as NPA, the banker should look for early
warning signals of NPA.
The following are the sources from which the banker can detect signals, which
need quick remedial action:
Scrutiny of accounts and ledger cards During a scrutiny of these, banker
can be on alert if there is persistent regularity in the account, or if there is
any default in payment of interest and installment or when there is a
downward trend in credit summations and frequent return of cheques or
bills,

Scrutiny of statements If the scrutiny of the statements submitted by the

borrower reveal a sharp decline in production and sales, rising level of
inventories, diversion of funds, the banker should realize that all is not well
with the unit.

External sources The banker may know the state of the unit through
external sources. Recession in the industry, unsatisfactory market reports,
unfavourable changes in government policy and complaints from suppliers
of raw material, may indicate that the unit is not working as per schedule.

Computerization of loan monitoring In computerized branches, it is

possible to computerize the loan monitoring system so that accounts, which
show signs of sickness or weakness can be monitored more closely than
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Nonperforming Asset in Bank

other accounts. Personal visit and face-to-face discussion By inspecting the

unit the banker is able to see for him where the problem lies either
production bottlenecks or income leakage or whether it is a case of willful
default. During discussion with the borrower, the banker may come to know
details relating to breakdown in plant and machinery, labour strike, change
in management, death of a key person, reconstitution of the firm, dispute
among the partners etc. All these factors have a bearing on the functioning
of the unit and on its financial status.

Strategy for reducing provision The extent of provision for doubtful asset is
with reference to secured and unsecured portion. Cent percent provision needs to
be made for the unsecured portion. If banks can ensure that the loan outstanding is
fully secured by realizable security, the quantum of provision to be made would be
less. It takes one year for a sub standard asset to slip into doubtful category.
Therefore, as soon as an account is classified as substandard, the banker must keep
strict vigil over the security during the next one year because in the event of the
account being classified as doubtful, the lack of security would be too costly for
the bank.
Cash recovery Banks, instead of organizing a recovery drive based on over
dues, must short list those accounts, the recovery of which would provide impetus
to the system in reducing the pressure on profitability by reduced provisioning
burden. Vigorous efforts need to be made for recovery of critical amount (overdue
interest and installment) that can save an account from NPA classification:

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Nonperforming Asset in Bank

a) In case of a term loan, the banker gets 90 days after the date of default to take
appropriate action and to persuade the borrower to pay interest or installment
whichever is due.
b) In case of a cash credit account, the banker gets 90 days for ensuring that the
irregularity in the account is rectified.
c) In case of direct agricultural loans, the account is classified NPA only after two
crop seasons (from sowing to harvesting) from the due date in case of short
duration loans and one crop season from the due date in case of long duration
loans.
Up gradation of assets Once accounts become NPA, then bankers should take
steps to upgrade them by recovering the entire overdues. Close follow-up will
generally ensure success.
Compromise settlements Wherever feasible, in case of chronic NPAs, banks
can consider entering into compromise settlements with the borrowers.

Reasons Behind NPA:1. Lack of proper pre enquiry by the bank for sanctioning a loan to a customer.
2. Non- performance of the business or the purpose for which the customer has
taken the loan.
3. Willful defaulter.
4. Loans sanctioned for the agriculture purposes.
5. Change in govt. policies leads to NPA.

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Nonperforming Asset in Bank

CHAPTER6: CONCLUSION
The Indian banking sector is facing a serious problem of NPA. The extent of NPA
is comparatively higher in public sectors banks. To improve the efficiency and
profitability, the NPA has to be scheduled. Various steps have been taken by
government to reduce the NPA. It is highly impossible to have zero percentage
NPA. But at least Indian banks can try competing with foreign banks to maintain
international standard. I would suggest 3 ways of solving this problem of NPAs.
They are
recapitalization of banks with Government aid,
disposal and write off of NPAs,
Increased regulation.

Various steps have been taken by the government to recover and reduce NPAs.
Some of them are.
1. One time settlement / compromise scheme
2. Lok adalats
3. Debt Recovery Tribunals
4. Securitization and reconstruction of financial assets and enforcement of Security
Interest Act 2002.
5. Corporate Reconstruction Companies
6. Credit information on defaulters and role of credit information bureaus

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Nonperforming Asset in Bank

CHAPTER7: REFERENCE
BIBLIOGRAPHY
Commercial bank management
----Peter.S.Rose
Principle and practices of Banking and Insurance
----P.K.Bandgar

WEBSITES
www.google.com
www.scribd.com
www.Wikipedia.com

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